Battered cannabis investors still seek bottom after Canopy plunges

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Canopy Growth Corp. led another mass selloff in the Canadian cannabis space Thursday after an earnings miss had investors once again looking for a bottom in the battered sector.

Canopy closed down more than 14 per cent after posting a net loss of $374.6 million for its fiscal second quarter, and shares are now trading at levels not seen since December 2017.

Both retail and institutional investors have called the bottom on the cannabis industry multiple times through an eight-month-long bear market that has seen the North American Marijuana Index shed almost 60 per cent of its value. But instead of investing in these stocks right before a rebound, they caught falling knives.

Finding a bottom in cannabis stocks has proven to be particularly challenging, given the constant cycle of bad news, including a lack of profitability, significant writedowns and, in some cases, dwindling cash reserves and withdrawn guidance.

“Every time you think we’ve seen most of the bad news, along comes comes something like today with Canopy,” said PI Financial analyst Jason Zandberg. “It’s almost impossible to pick where the very bottom is because it doesn’t become a function of valuation, it becomes a function of fear and panic when the stocks are being sold off.”

And the selling isn’t likely finished yet, Zandberg warns. He expects the stocks to continue to trend lower throughout December as investors engage in tax-loss selling to offset their portfolios’ winners. If investors are willing to take the risk from there, Zandberg suggests they have to be stringent in their selection criteria — or risk investing in a company that may not be around for much longer.

Companies need a niche or defendable market share to separate themselves from the pack, he said, pointing to Supreme Cannabis Company Inc., which is known as a premium flower seller. Next, investors should look into the fundamentals, he said, and see whether their prospective investments have an operating cash flow. There were only six or seven such names that did the last time Zandberg checked.

“In order to win, you’ve got to have a ticket and in order to get a ticket, you’ve got to have cash,” he said.

Richard Croft, chief investment officer at the Toronto-based Croft Financial Group, remembers looking at the cannabis space in 2017 before the large runup and not being convinced by the sector. That stance made him miss out on the green wave, he admits, but with stocks selling off, he’s not being tempted to look for an entry point. Instead, he’d prefer taking a covered call strategy.

The only one I’d look at is Canopy and I don’t think I’d be jumping into that one either

Richard Croft, chief investment officer, Croft Financial Group

“The only one I’d look at is Canopy and I don’t think I’d be jumping into that one either,” said Croft, who said he’d be looking for a bottom by determining whether the stocks have moved two standard deviations below their 50-day moving averages.

Zandberg expects that in January the markets will finally begin to turn around from the rollout of edibles, vapes and extract products.

It’s the failures in the recreational market that have led Purpose Investments portfolio manager Greg Taylor to significantly lower his exposure to Canadian cannabis LPs. Taylor holds a higher cash position — 20 per cent — than he does in Canadian cannabis stocks — about 15 per cent. The bulk of his portfolio is in U.S. cannabis stocks.

The rollout of recreational cannabis hasn’t been as successful as investors hoped, said Taylor, who pointed specifically to Ontario. There are only 24 retail stores in operation in the province, whereas Alberta, where the population is about one-third of Ontario, has more than 300. Licensed producers built up massive inventories they could not sell and have to readjust to a reality in which there’s a lack of retail space.

The only plays Taylor still sees upside in are the extractors who will benefit from the rollout of cannabis 2.0 products. For the others, he recommends taking a wait and see approach until “Ontario is fixed.”

“The space could be in the penalty box for a while in Canada and people who want exposure will be looking elsewhere,” Taylor said.

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